Nafta Essay, Research Paper

Introduction

Summary

In January 1994, the United States, Mexico, and Canada implemented the North American Free Trade Agreement (NAFTA). The goal of NAFTA is to create better trading conditions through tariff reduction, removal of investment barriers, and improvement of intellectual property protection. NAFTA continues to gradually reduce tariffs on set dates and aims to eliminate all tariffs by the year 2004.

Before NAFTA was established, investing in Mexico was a difficult process. Investors needed the Mexican Government’s approval and were also required to meet specific investment guidelines. These requirements necessitated investors to export a set level of goods and services, utilize domestic goods and services, and transfer technology to competitors. Under NAFTA, investors no longer need government approval to invest and are treated as domestic investors. NAFTA has also increased intellectual property rights and allowed companies to obtain patents in Mexico and Canada. In the past, companies were hesitant to export research and development intensive goods; with increased intellectual property protection, however, exports of these goods has shown a definite increase.

As a result of better trading conditions, exports and imports of most other goods have increased along with the research and development intensive goods. In Mexico, the elimination of investment barriers has allowed investment to expand. Increased trading and investment has then created many jobs, raised the Gross Domestic Product, and lowered consumer prices. The macroeconomic principles defined in Economics 103 relate to NAFTA’s impact on aggregate supply and demand, employment, investment, and their effects on national income.

The free trade established by MERCOSUR also involves countries within South America. MERCOSUR, the Southern Common Market ( Mercado Common del Sur) was established in 1991 after a series of other free trade treaties failed to meet the standards of the countries involved. It is set up on the basis of free trade zones and eventually to lead to a common market. Before MERCOSUR there was ALALC, the Latin American Free Trade Association. It was formed in 1960 and set up free trade zones through the periodic negotiations between the members of the association. ALALC ended in the 1970’s due to these negotiations because they were left to the discretion of the countries involved and unfair practices started to occur. After ALAC, came ALADI, the Latin American Integration Association. Founded in 1980, it established economic preference zones instead of free trade. This encouraged economic growth and increased actions and agreements between countries that previously had no connections. In 1986 Argentina and Brazil signed a Treaty for Integration, Cooperation, and Development which was originally set up to remove tariff barriers and tie together the macroeconomic policies of the two countries. This Treaty is what led to MERCOSUR. MERCOSUR is a process of integration to form a common market on the foundations of open regionalism. In March of 1991 Paraguay and Uruguay joined MERCOSUR and most recently Chile became a part of the market in 1996. The goals set by the agreement are to create free transit of production goods and lifting of non-tariff restrictions on transit goods. It was set up to adopt a common trade policy with nations that are not a part of the market and to set up a fixed common external tariff for all to follow. There are quite a few other goals that was set by MERCOSUR including a clause that states that the countries involved will be able to adjust their laws for the purpose of strengthening the agreement. The main point of MERCOSUR is to set up free trade among South American countries and to encourage new countries to join (americasnet.com).

Another related trade agreement conveying the benefits of international trade is the General Agreement on Trade and Tariffs (GATT). A trade agreement that conveys the positive outcomes of international trade is the General Agreement on Trade and Tariffs (GATT). It was created in 1947 and like NAFTA promotes international trade through the reduction of tariffs. Today, GATT encompasses over one hundred countries and 90% of the world’s trade goods (Sabir 1). There have been eight different versions of GATT, each resulting in a new trade agreement. The most recent is referred to as the Uruguay Round and is one of the largest and most comprehensive trade pacts in history (Deng 1). The Uruguay Round Agreement cuts tariffs by one-third, increases coverage for textiles, clothing and agriculture and creates a new World Trade Organization (Congressional Digest 258). The WTO settles dispute settlements, regulates the policies agreed upon and reviews countries’ trade practices and policies. In addition, the Uruguay round proposes reductions in nontariff protective barriers to trade (Gottheil 350). The Uruguay Round and WTO make up an important part of GATT. GATT as a whole is based on principles that ensure all participating countries receive benefits. These principles include nondiscrimination, protection of domestic industries and provision of stable basis for trade (Congressional Digest 258). With such a solid foundation, the policies of GATT have taken force. Much like NAFTA, GATT proposes to increase trade through the reduction of tariffs. However, GATT is more inclusive of the international economy.

As NAFTA, MERCOSUR, and GATT establish free trade throughout the Americas and other parts of the world, the European Free Trade Agreement (EFTA) represents countries throughout Western Europe. It was initially formed in 1960 by Austria, Denmark, Norway, Portugal, Sweden, Switzerland, and the UK. The overall objective of the EFTA and of these founding states was to remove trade barriers throughout Western Europe, such as import tariffs and quotas, and to uphold open practices in world trade (EFTA Page). The framework of the EFTA has changed significantly since its initial founding as many member states have come and gone along the way. In 1972, the existing EFTA countries signed free trade agreements with the European Union, thus eliminating import tariffs on industrial products. Since then the EFTA has worked to strengthen its relationship with the European Community. The current constituents of the ever changing EFTA include Iceland, Liechtenstein, Norway, and Switzerland (EFTA Page).

The free trade agreements established by the EFTA cover intra-EFTA trade, trade with the European Union, and free trade outside of the EFTA or EU. The EFTA is currently in the midst of procuring free trade agreements with countries in Central and Eastern Europe and even with other countries around the world (EFTA Page). These free trade agreements serve to promote unified movement within the EFTA’s economic relationships and to strengthen Europe’s international trade alliances. According to EFTA web page, free trade established by the EFTA is an, “essential process in the continuous building of economic, social, and political ties between the countries of Europe and thus enhancing our common objective of closer European integration” (EFTA Page). Agreements with the EFTA reduce tariffs between countries, enhance and allow for more stable foreign investment, and support the removal of trade barriers. In establishing all of these rights, the EFTA hopes to create an environment that is supportive of entrepreneurship, competition, and economic activity within its various market structures (EFTA Page).

Analysis

Free Trade agreements are prevalent throughout the world, each representing trade within a particular region. The success of free trade is unique to each individual trade organization. NAFTA, MERCOSUR, GATT, and the EFTA, overall, have created founded many positive aspects in international trade. The free trade that NAFTA has established among the United States, Mexico, and Canada has greatly benefited the U.S. economy. During the years from 1994 to 1997, U.S. trade with Mexico and Canada rose 44 percent. This extensive growth is accredited primarily to the reduction of tariffs. As tariffs were lowered, U.S. goods became cheaper and more competitive in Mexican and Canadian markets, and at this lower price level the quantity demanded of U.S. goods increased. On the attached graph, as the price level drops from A to B, the quantity demanded increases from C to D; it becomes less expensive for U.S. firms to supply goods to Canada and Mexico as the supply curve shifts from AS to AS’. In order to meet the new demand, the firms must hire new workers and increase investment. Between 1994 and 1997, 90 to 160 thousand jobs were created in the U.S. due to the increase of trade with Mexico, and 2.4 million jobs were dependent upon trade with Mexico and Canada. The increase in employment and investment then leads to increased national income.

The work of NAFTA has also served to benefit Mexico’s economy; in accordance with the United States’ economy, Mexico’s exports have increased, more than doubling since 1993. The elimination of investment barriers has caused a dramatic rise in foreign investment from four billion in 1993 to ten billion dollars in 1998. NAFTA has enabled Volkswagen, IBM, and the textile industry to seek labor and materials in Mexico. In 1994, a Canada-based entrepreneur invested four million dollars in a metal-stamping plant. The plant is now a major material suppler for Volkswagen although it was originally intended to employ only 130 people. The plant currently employs 1,300 workers and generates 57 million dollars in sales each year. NAFTA has also allowed IBM to create plants in Guadalajara that would otherwise have been built in Asia. As a result, the exports of IBM de Mexico have increased from 350 million to 2 billion dollars in five years and the increased exports have created over 270 jobs. Mexico’s textile industry, too, has grown as a result of NAFTA, in 1996 overtaking China to become the largest supplier of textiles to the United States. U.S. mills invest hundreds of millions of dollars to build plants in Mexico as an effect of the reduced tariffs and shipping time. It takes only eighteen hours to ship goods to the Mexican border, while it takes twenty-one hours to China. Increased investment and exports have created jobs and increased GDP. In 1998, Mexico’s economy grew 4.5 percent and economists predict that it will grow an additional 2.5 percent in ‘99.

Free trade under NAFTA has also encouraged international specialization, the production of only the goods that a particular economy can produce most efficiently. If the U.S. for example, is efficiently manufacturing cars and Mexico, producing corn, then the U.S. should produce only cars and Mexico, only corn. They are more efficient if they each produce at their highest output, and trade for other goods. International specialization increases efficiency, lowering consumer prices; consumers no longer have to pay for inefficiently produced goods. The benefits of NAFTA are therefore, increased employment, raised national income, and lower consumer prices.

MERCOSUR, again like NAFTA, has had an overall positive influence on free trade throughout the Americas. The economic goal of MERCOSUR is to be able to coordinate the macroeconomic and sectional policies of the countries involved in relation to foreign trade and several other common markets. It also ensures free trade competition among the nations with in the agreement. It was formed to improve the economies by making them more competitive and efficient (Embassy of Uruguay). The time line goal of MERCOSUR was to start with Argentina and Brazil in 1995 to reduce tariffs some and in 1996 to reduce tariffs by 25 percent and increase each year by another 25 percent until in 1999 tariffs were 100 percent gone. Because Paraguay and Uruguay joined the Treaty later the dates for the elimination of their tariffs are pushed back a whole year so that by the year 2000 they will have 100 percent eliminated tariffs. The downfall of this elimination of tariffs is that some businesses will have to cut back and restructure so some people will loose their jobs, but in the long run the economy will grow stronger from it. However, the social security system for the countries will be transformed such that a worker can work in any of the member countries and accumulate years until retirement and still receive a pension (americasnet.com).

Each of the countries is using MERCOSUR in a different way to increase their productivity. In Brazil through privatization they use MERCOSUR to attract outside investors for industries and services to improve roads and railways and other large industries like power. Argentina is also using privatization to increase opportunities with their airports. Paraguay and Uruguay are taking more advantage of the integration process. In Paraguay they are using it to increase and improve waterways and in Uruguay the are using it to build a bridge and distribute gas and electricity (americasnet.com).

All of the countries have increased their GDP since the induction of MERCOSUR and have become more economically independent. Argentina has gone from a recession in 1988 through an incredible recovery through to 1996. They have increased their exports by 13,000 form 1993 to 1997 and exports have increased by 15,000 in the same period of time (Argentina Brief). Other MERCOSUR countries have experienced the same results and are continually growing. The one exception to the benefits of MERCSUR would be the economy of Paraguay. Before they joined the market, they were the best performing country in the region, but now they have fallen behind all the other members in MERCOSUR as a result of the political instability and small domestic market (Sabkar, Maysoon).

The effectiveness of GATT is that it applies to a majority of the economy. In the market of major industrial goods, tariffs have been eliminated and reduced in the developing markets of: construction equipment, agricultural equipment, medical equipment, steel, beer, distilled spirits, pharmaceuticals, paper, toys and furniture (Congressional Digest). These are some of the most important industries in the United States and are some of the most competitive in the world. As stated by the US report on GATT, a key provision was that it “significantly lowered access to markets that represent approximately 85% of world trade in terms of reduced tariffs on specific items of key interest to US exporters”. There have been tariff reductions ranging from 50 to 100% on important electronics software (US report on GATT 2). The most important sector to be included is agriculture. For the first time, all agricultural tariffs are bound and reduced. GATT strengthens long term rules for agricultural trade, reduces agricultural export subsidies and opens new markets. Intellectual property such as patents, trademarks and copyrights for movies, computer programs, books and music is also protected. Many of the industries listed above deal with technology and are crucial to everyday life. By promoting the reduction of tariffs in the sectors of the economy important to the United States, industries will be able to expand and grow.

The way that industries will be able to grow is through the reduction of tariffs. While barriers to trade come in many forms, the tariff has been used to protect domestic industries from foreign competition. The negative aspect of tariffs is that they reduce the amount of goods produced for export. Graph 1 exhibits the effects of a tariff on quantity supplied by United States. Let’s suppose the tariff is on imported French wine. At normal equilibrium, quantity demanded of wine equals quantity supplied at one hundred billion and a price of $2. That is the United States would supply 1 billion bottles of wine. However, a tariff creates a situation similar to a price ceiling. The tariff causes the price to decrease to $1 and the quantity supplied decreases to .5 billion while quantity demanded increases to 1.5 billion. The effect of the tariff is to decrease the quantity supplied by the United States. To producers in the United States that means a decrease in the production of goods and services. The reverse happens when the tariff is reduced. Quantity supplied will increase, that is more goods will be produced for trade.

This increase in exports has other implications on the economy. Since exports will be increasing at a higher rate than imports the net exports will be positive. Aggregate expenditure equals spending by consumers, investors, government and net exports. An increase in the net exports will increase the aggregate expenditure shifting it to the right. This is seen in graph 2, where the aggregate expenditure curve (AE) shifts to the right (AE’). As shown by the graph, the level of national income increases from 250 billion to 300 billion. Therefore, increasing net exports will increase the level of national income. “By eliminating import taxes, world income will increase as much as $5 trillion in the next 10 years. Higher world incomes mean more demand for our commodities” (Kleckner 1). With an increase in national income, the standard of living in the United States and other participating economies should increase. More jobs will be created for the unemployed, helping the economy reach the full employment level. At this level, all resources would be in use.

Similar to other free trade agreements, the purpose of those formed through the EFTA is to strengthen European as well as international economies. In establishing a strong foundation for free trade, it seems that the EFTA has done much good for economies within Europe. According to the EFTA web page, “Ministers emphasize EFTA’s strong credentials as a free trade organization and underline that free trade and economic integration play an increasingly important role in securing work, welfare, peace, and democracy in Europe” (EFTA Page). Its visible effects on international trade provide only a nominal indication of the many accomplishments of the EFTA; its work can also be observed in terms of its underlying affect on the economy. In establishing strong international relationships, it has expanded the level of exporting and importing, increased employment, raised consumption, and in effect, also enhanced the average GDP for countries active in the EFTA (Fortune). Each part of this integration serves a beneficial purpose, and positive aspects of the EFTA’s work are evident in economies throughout Europe.

As the EFTA has worked to strengthen relationships not only within its member countries, but all over Europe and the rest of the world, it has established many alliances, thus creating a solid base for foreign trade. The level of exporting and importing, particularly among European countries has shown a definite increase. The expansion of foreign trade creates potential for more employment opportunities; it can also be directly related to its aggregate supply, and in effect, its level of GDP. The increase in exporting, being a significant expenditure included in the calculation of GDP, is shown in its effect on GDP growth.

Within the free trade of the EFTA, the level of employment in member countries also has been affected. As the degree of economic activity increases due to free trade alliances, many areas, including that of employment also begin to change direction. The expansion of exporting mentioned before plays a role in the variable level of employment. Increased employment will add to the level of human capital as rising imports and exports expand capital resources, thus contributing to an outward shift in the aggregate supply curve. Any increase in resource availability for land, labor, capital, or entrepreneurship will allow for an outward shift in the production possibilities curve, followed by a similar shift in the aggregate supply curve, eventually increasing real GDP. Rising employment can also effectively create a rise in consumption and in average national income, ultimately adding to real GDP.

Consumption can be affected not only by a rise in the employment level, but also by the reduction in tariffs provided by the EFTA. When consumers have to pay less for their goods, their level of real wealth has the effect of increasing. Lower prices enable them to buy more goods with the same level of income; there is the illusion of greater income. This feeling of increased wealth, along with a rise in the actual level of employment, contributes to increased consumption. The increasing degree of consumption will, again, lead to greater national income, and to a higher level of real GDP.

A rise in trade combined with increasing levels of employment and consumption allows for potential growth in the level of GDP. According to Fortune magazine, the average GDP of those countries belonging to the EFTA rose an average of 2.1% each year (Fortune 7). As trade, employment, and consumption increase together, GDP has a tendency to do so as well. EFTA countries approaching a level of full employment due to changes in trade, tariffs, and consumption will eventually experience its beneficial effect on the economy.

Conclusion

In general, it seems that each of the researched trade agreements has been successful in promoting overall economic growth throughout the regions of the world.

NAFTA

MERCOSUR

The positive effects of GATT are numerous and widespread. GATT has proved to be highly successful in removing barriers to trade in goods. In eight consecutive rounds, GATT has lowered tariffs on manufactured products from more than 40% to below 4% among developed nations. “In part as a result, world merchandise trade, measured in the tens of billions of dollars at the inception of GATT, now stands at $5 trillion” (Break down the barriers). This growth has brought prosperity to developed countries as well as developing countries. Some of these benefits are result of the larger scope of world trade rules and the large proportion of the economy that is covered under GATT.

The EFTA has been fairly effective in following through with its one underlying goal, the removal of trade barriers within and outside of the EFTA. It has also been proficient in cultivating its relationships with third world countries. Its success in these areas has allowed for the growth of its member countries in areas of trade, employment, consumption, and eventually also national income and real GDP. It seems, however, that it needs to do more in order to have a more influential presence.

Since its initial founding, the number of member-countries in the EFTA has dwindled from seven to only four. The EFTA is clearly not the most prominent free trade organization in Europe; it is apparent that the European Union holds the position of dominance, as many EFTA countries have defected to the EU over the years. The EFTA’s minority power in Europe and the simple reality of its size may cause many countries to brush it aside. While it has united with the European to Union to accomplish many things such as the European Economic Area, it might be more effective if it could handle more significant matters on its own.

Bibliography

EFTA Page. EFTA Secretariat EFTA Surveillance Authority EFTA Court. 23 March 1999 *http://www.efta.int/structure/main/index.html*.

“How They Add Up.” Fortune 126.13 (14 Dec. 1992): 152 – 153.

http://www.americasnet.com/mauritz/mercosur/english ; MERCOSUR

Sabkar, Maysoon; http://bmb.net/our_views/Reports/Country/paraguay_1.htm , 1998

http://www.embassy.org/uruguay/econ/mercosur/merc-002.htm ; Embassy of Uruguay, Washington D.C. 1996

http://www.heinlein.com.ar/eco.htm ; Argentina Brief